Source: Table 5.2, The Most Important ThingHigher Investment Risk and Expected Return
I’m
currently reading the book The Most Important Thing: Uncommon Sense for
the Thoughtful Investor by Howard Marks. Inside, he talks a lot about
risk. Most people seems to grasp the idea that riskier investments offer
the prospect of higher returns. Stocks are expected to offer higher
returns than stocks. Bonds are considered less risky, and thus return
less. However, Marks states that too many people have a simplistic
risk/return relationship in their heads:
However,
there is no requirement that riskier investments will actually provide
those higher returns. It’s only the average expected returns that are
higher, but since the uncertainty is also higher. Put another way, the
distribution of potential returns is wider. To be more precise, he
shares this risk/expected return chart instead:
Source: Table 5.2, The Most Important Thing
When
I started investing several years ago, I remember reading several
personal finance articles that responded to questions from older
investors that had some catching up to do with their nest eggs. The
solution was simple – own more stocks! You’ll need the extra return,
they reasoned. That’s exactly the wrong way to think. There is no easy
shortcut to saving more.
Source: Table 5.2, The Most Important Thing